9 0 market power market failure and general equilibrium
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9.0 Market Power, Market Failure and General Equilibrium. 9.1. Pareto optimal general competitive equilibrium is a special case of all the possible equilibria There are others that are possible when market power and market failure exist. Giving “A” market power,. the pie is smaller,

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9.0 Market Power, Market Failure and General Equilibrium

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9 0 market power market failure and general equilibrium

9.0 Market Power, Market Failure and General Equilibrium


9 0 market power market failure and general equilibrium

9.1

Pareto optimal general competitive equilibrium

is a special case of all the possible equilibria

There are others that are possible when market power and market failure exist


Giving a market power

Giving “A” market power,

the pie is smaller,

but A has a larger share of the pie


9 2 1

9.2.1

Exercising market power is not productive

It is exploiting an advantage that you have over the market

If you have it, it is wonderful

There are costs, though-

Smaller piece for others

Makes the system less efficient


9 2 2

9.2.2

Monopoly – being the only seller in a market

Monopsony – being the only buyer in a market

Here, you are not a price taker

You can choose price/quantity combinations that are most advantageous


There are two sources of market power

There are two sources of market power:

Naturally occurring and

Artificially created


9 2 3

9.2.3

Naturally occurring market power does not come from distortions within the market process

They just happen

Ex. Supermodels, Michael Jordan

Egg donation – NY Times ad


9 2 4

9.2.4

The naturally occurring market power might have different effects in different markets

Ex. Basketball vs. Tiddlywinks


9 2 5

9.2.5

Why did Michael Jordan make so much?

Huge derived demand and limited possibilities for input substitution

Best possible case for a worker

Did he work hard?

Yes - making the most of his natural gift


9 2 6

9.2.6

If a firm produces huge amounts of a product,

it may begin to experience economies of scale-

because of the size of your operation, you can make things much cheaper per unit


A firm that experiences large economies of scale

A firm that experiences large economies of scale

call kill off all competition by virtue of this “head start”

It will be able to underprice any new entrant

Economies of scale can be a barrier to entry to a market

This can lead to a natural monopoly -

a single supplier with no competition


9 2 7

9.2.7

Natural advantages may slip away

Bodies get older,

firms face new technologies, etc


9 2 8 artificially created market power

9.2.8 Artificially created market power

Patents – don’t occur in nature, come from governments

Firms sometimes buy up patents to protect their market power


9 2 9

9.2.9

Rent-maintenance – the exploitation of institutional power to sustain a market advantage

Ex. Donations to Congress or other rules-makers to prevent competition for your firm


9 2 10

9.2.10

Sometimes it’s not just about sustaining your advantage

Rent-seeking is when you try to create an advantage that isn’t there now

Lobbyists also do this


9 2 11

9.2.11

Smith pointed to rent-maintenance and rent-seeking

as threats to the market system in Great Britain


9 2 12

9.2.12

Artificial market power can be created through political institutions,

but social institutions can also factor into our perceptions of what is appropriate for

certain genders or races


9 2 13

9.2.13

Not only may social forces alter your own perceptions about what you may become,

they may also affect those who hire/admit you

This is a powerful, yet almost invisible, constraint that yields artificial market power for the privileged


9 2 14

9.2.14

Two jobs

MS = Men’s sphere

WS = Women’s sphere

Comparable jobs

Men’s sphere has higher pay to start


What happens with no market power

What happens with no market power?

Workers enter MS market, supply shifts out

As people leave WS, supply shifts back

Wage falls until all advantage is gone


9 2 15

9.2.15

Relaxing the nice assumption of equal access to markets

If women are crowded into a certain set of jobs, excess supply – lower wages

And

This also restricts supply in male set of jobs – so higher wages result because of no female competition


9 2 16

9.2.16

Market power lessens efficiency

Firms don’t have to be totally efficient because perfect competition isn’t forcing them to do so

Pareto optimality is not reached


Equity fairness is another matter

Equity – fairness – is another matter

Those with market power can alter the distribution of benefits to their advantage

Is that fair?

Maybe or maybe not, but it is a different yardstick


9 2 17

9.2.17

Apartheid in South Africa

Whites were a minority, but had a vast majority of the wealth

Limiting opportunities for Blacks preserved that power advantage

Education, or a lack thereof, had economic consequences


9 2 18

9.2.18

High skill versus low skill jobs

Without market power


With market power of apartheid

With market power of apartheid


9 2 19

9.2.19

Limits on education weren’t the only ones

Limits on mobility – passes

Limits on access to markets

All were “legal” – enforced by police and military


9 2 20

9.2.20


South africa paid a price for this system

South Africa paid a price for this system

Loss of efficiency

Most of the population’s energy and creativity is blocked out

Pie could have been larger

Resources spent on rent-maintenance could have been better spent


9 2 21

9.2.21

The price of maintaining that advantage grew more and more expensive

Popular revolt – more jails and jailers

International sanctions hurt

Eventually Mandela goes from jail to President

Just changing laws is not the only change to make it a fair society


9 2 22 conclusion on market power

9.2.22 Conclusion on market power

It often exists

It reduces efficiency and changes the equity of the market system

Understanding the effects of market power enriches our analysis of the world

We have a much more realistic model


9 3 1 market failure

9.3.1 Market Failure

We assume markets will form to quickly coordinate choices

If the market doesn’t form, or can’t coordinate well,

we have a case of market failure

There are several types of market failure:


9 3 2 public goods

9.3.2 Public Goods

a public good is non-partitionable and non-excludable

Ex. National Defense


9 3 3

9.3.3

Public goods suffer from the free rider problem

If you believe you will get the benefit without paying, you might not pay

Ex. PBS - public television, National Public Radio

If everyone behaves as a free rider, the good might disappear


9 3 4

9.3.4

Another type of market failure is an externality

This occurs when property rights can not be assigned or enforced


9 3 5

9.3.5

Air rights

Air can be used for breathing, or as a place to dispose waste

Ex. Smoking or polluting

A firm which pollutes has a consequence to others, but

its effect is external to its own assessment of the cost of the activities


9 3 6 9 3 11

9.3.6 - 9.3.11

The problem becomes that there is no market for air

there is no price signal

There is no way to quantify the external effect on others caused by their activity


These two examples are called

These two examples are called

negative externalities because there is an external cost to others

It is also possible to have a positive externality which adds an external benefit to others

Ex. Beekeeper -

pollinates local plants, too

Piano lesson -

music spills over to others


In the case of a negative externality

In the case of a negative externality,

the Marginal Social Cost = Marginal Private Cost + Marginal External Cost

MSC = MPC + MEC

or MEC = MSC - MPC

If there is no externality, MEC = 0 and

MPC=MSC


In the case of a positive externality

In the case of a positive externality,

the Marginal Social Benefit = Marginal Private Benefit + Marginal External Benefit

MSB = MPB + MEB

or MEB = MSB- MPB

If there is no externality, MEB = 0 and

MPB=MSB


Since society as a whole must consider

Since society as a whole must consider

all costs and benefits when determining an optimum,

from a societal point of view, one should produce where

MSB=MSC


However

However,

a private firm has its own decision rule

they produce where MPC=MPB


If no externalities exist

If no externalities exist,

then private optimization means social optimization

this is not always the case when you have market failure


Graphical representation negative externality

Graphical representation - Negative Externality

MSC = MPC +MEC

MEC

MPC

MPB=MSB

Ls

Lp

Output


With negative externalities

With negative externalities,

firms tend to overproduce because

the market failure means the market does not allow

them to realize the extra “bad” that they do


Graphical representation positive externality

Graphical representation - positive externality

MPC = MSC

MSB = MPB +MEB

MEB

MPB

Lp

Ls

Output


With positive externalities

With positive externalities,

firms tend to underproduce because

the market does not reflect the extra “goodness” they do


9 3 12

9.3.12

Risk eternality - creating an unintended risk for others

Ex. Drunk driving


9 3 13

9.3.13

Risk externalities and technology

Scientific experiments sometimes create unintended consequences


9 3 14

9.3.14

Firms and individuals act in self-interest, but

unintended costs and benefits affect others

Market failure is why this happens

Lack of property rights, no price signal, etc.

What happens when markets fail?

Some feel this is is where government should get involved


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